The geographical distribution of R&D investment changes dramatically in the 1970s
and 1980s. In the early 1970s U.S. firms are the uncontested world leaders in R&D
investment in most manufacturing sectors. Later, led by Japan and Europe, foreign firms
start challenging American R&D leadership in many sectors of the economy. In this
period of increasing competition we also observe a substantial increase in the U.S. R&D
subsidy. In a version of the multi-country quality ladder growth model I study the
effects of foreign R&D competition on domestic welfare and on the optimal R&D
subsidy. I build a new empirical index of international R&D rivalry that can be used to
perform quantitative analysis in this type of frameworks. In a calibrated version of the
model I focus on the period 1979-1991 and perform the following quantitative
exercises: first, I evaluate the quantitative effects of the observed increase in foreign
R&D competition on U.S. welfare. I find that the positive growth effect and the
negative business-stealing effect of foreign competition on U.S. welfare substantially
balance each other, and the overall welfare effect of competition is negligible - less then
1 percent of per-capita consumption. Moreover, using estimates of the effective U.S.
R&D subsidy rate, I compute the distance from optimality of the observed subsidy at
each level of competition. I find that international competition increases the optimal
subsidy and that, surprisingly, the U.S. subsidy observed in the data is fairly close to the
optimal subsidy.